Facebook and others have tapped into the power of viral loops to build massive audiences in record time. Now they’re using these growth engines to create the future of online advertising.

Some of the most iconic companies of our time — Facebook, MySpace, YouTube, Twitter — attracted millions of users practically overnight, by unleashing what’s known as a “viral-expansion loop.” In plain English, they grew because each new user led to more users. The trick is that each of these businesses created something people really want and then made it easy for customers to happily spread their products for them to friends, family, and colleagues.

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I started exploring the phenomenon 18 months ago, in a cover story for Fast Company about Ning and viral loops, and my research grew into a book, out this month, about how viral loops are at the core of fast-growing social-media phenomena. In addition to the compelling genesis stories of how these startups became media darlings, what intrigued me was this question: What does size matter if you can’t figure out a way to make money off a massive audience? Simply layering in banner ads (or ads of other stripes) can alienate your user base and often doesn’t even work — a problem that continues to plague MySpace and YouTube despite any claims to the contrary. And if you start charging, your customers are but a click away from someone who doesn’t. Of course, this marketing conundrum afflicts more than just viral-loop companies. It has been the undoing of online news and entertainment, neither of which has been able to conceive of a way to ratchet up revenue through advertising to a point of sustainability.

The culprit: the oft-tried-but-not-true clickable banner ad, whose click-through rates now hover around 1%. It’s even worse on social networks, where the rate is a measly 0.02%, a far cry from when the Web was so new that 50% of users clicked simply because they’d never encountered banners before. (Hey, what does this button do?) Banner ads are victims of the modern cat-and-mouse game between marketers and consumers. (They barrage us with TV ads; we get DVRs. They create pop-up ads; we get pop-up blockers.) The more time people spend online, the more likely they are to become inoculated against the latest marketing technique.

There’s a move afoot to go beyond the banner, and if successful, it would breathe new life into the ad-supported model that millions rely on — and by which few are sustained. It could also end the push-pull between marketers and users. Some of the more intriguing innovations would measure both your implicit value to these social networks and the value of all your friends, your interactions with them, and your influence over them. Then it’s not about click-throughs anymore. It’s about you.

Death to the Banner

Today’s conventional wisdom is that marketers can’t reach the 1 billion users worldwide on social networks, dooming Facebook, MySpace, and the many other social networks out there. This moment in time is not unlike the one a decade ago when experts claimed that search was not a stand-alone product because there was no way to monetize it. In response, Yahoo and its competitors vied to become superportals where a user’s every need was served on one megasite. Search, the thinking went, was good only for attracting users who would stay to sample a variety of other services like news, horoscopes, financial information, chat rooms, and so forth.

Then Google’s founders flipped over the conventional wisdom. They introduced a new ad unit, keyword search, which revolutionized the search industry by inferring the intent in users’ queries and catching them at the very moment they sought information. Google, by skimming nickels, dimes, and quarters off each click, rode it to a multibillion-dollar fortune.

If history is any guide, social networks won’t fade out as a fad — they just need to find their version of keyword search, the new ad unit that upends accepted orthodoxy. Realize there is power in numbers. If Facebook, which in July passed 250 million users worldwide, were to follow Craigslist’s model and monetize a fraction of its site — worth, say, on the order of $1 per month for each user — that would yield $3 billion a year in revenue. Marc Andreessen, who sits on Facebook’s board, claims that simply by placing ads on its home page, it could probably generate $1 billion a year. For his part, founder Mark Zuckerberg sees the answer in what has earned Facebook its stratospheric growth so far: the social graph that illustrates all the interconnections among people, groups, and organizations. “The message you get, in a lot of ways, is actually less important than whom you get it from,” Zuckerberg says. “If you get it from someone you trust, you’ll listen to it. Whereas if you get it from someone you don’t trust, you might actually believe the opposite of what they said. I think that’s the basis of the value that people get on the site.”

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It’s in this insight that Zuckerberg and others seek to find the business opportunity in people’s online interactions. Suddenly, the new ad unit isn’t about clicks anymore.

Crowd Control

Consumers will tolerate a whole lot of advertising if it’s disguised as entertainment, which is why marketers have responded to the DVR by making TV commercials more engaging — the kind that make viewers stick around — and integrating ads into shows. The same holds true for the Web, and as with keyword-search ads, the trick is to market to people in a way that doesn’t make them feel like they’re being marketed to. This is where Andy Monfried, CEO and founder of the social-media advertising and marketing firm Lotame, comes in.

For Monfried, an ad’s success isn’t based on how many people see the ad; it’s all about how much time someone spends engaging with it. Armed with a person’s age, gender, and zip code — bare-bones data sometimes collected directly from social networks, but not personal information that could be used to find out a person’s true identity — Lotame dispatches cookies to users’ machines and notes their online behavior. It’s not what users say, though. It’s what they do. “There are ways consumers use the platforms,” Monfried says of social networks. “They email, they blog, they comment, they post, they share, they link, they upload, they friend, they stream, they write on a wall, they update a profile. There are 160 verbs that we currently track.”

Monfried helps advertisers seek out influencers (or “connectors,” in Malcolm Gladwell parlance), the people who affect the buying habits of others, then cross-references their actions with the bare-bones demographic data he’s gathered. For example, Lotame recently helped a movie studio drum up interest for a new chick flick. Monfried was able to sell the advertiser access not to women in general, but specifically to 1 million American women between the ages of 14 and 24 who had uploaded, blogged, rated, shared, or commented on entertainment content in the previous 24 hours. This is a level of granularity never before seen in marketing.

The key is that Lotame isn’t just selling access to a specific and highly motivated audience. It’s selling time. The advertiser bought four minutes per user over a three-week period with the understanding that the clock would freeze whenever the user stopped interacting with the ad — in this case, a trailer for the movie. After Lotame identified the influencers, it targeted them with the trailer. A few thousand of them embedded the video in their social-network profiles or blogs. Then Lotame tracked the visitors — the legions of friends and acquaintances who swung by and viewed the trailer. Every person who fit the demographic profile was tallied and timed.

Most important, the video ad took advantage of a viral-expansion loop to fuel its spread. Lotame is engaging in a type of controlled virality that differs in two key ways from the strategies typically adopted by studios pushing hotly anticipated movies such as Where the Wild Things Are. It lets the studio — or any advertiser, from cosmetics companies to consumer-electronics manufacturers — make sure the right people see the ad. It also allows social networks to take a toll for facilitating its spread, all the while asking nothing of the audience but to do what it’s been doing all along.

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What Are You Worth to Facebook?

Facebook, of course, has spent the last couple of years on its own grand experiments trying to develop a new kind of ad unit. Beacon — a controversial advertising scheme “to socially distribute information on Facebook,” connecting businesses with users — was a public-relations fiasco. The company has also toyed with another approach, called Social Ads, although it hasn’t pursued this program aggressively while it’s been focused on growth. If a user buys a book on Amazon, or watches a movie on Hulu, Facebook could figure out which of his friends would, based on their profiles and activities on the network, be most interested. Amazon would then pay Facebook for the right to send an ad across all the friends’ news feeds.

But as signaled by Lotame’s work with brands as varied as Liberty Mutual insurance, Crest toothpaste, and Skittles candy, users create value through their actions in social media and the time they spend doing what they enjoy. And that points to a better way to market to users — cutting them in on the deal.

After all, each member of Facebook has to be worth something to the company. So it follows that the more active a person is and the more active his network of friends is, the more valuable he is. This led Vasanth Sridharan to suggest on the blog Business Insider that users receive a commission for acting as referral marketers — on the order of 5% to 10% on any purchases their friends make.

That way, Facebook would be treating its users as partners by giving them a financial incentive to participate in any advertising model it creates, no matter the form of the ad unit. If it shared some of the bounty, users would gladly interact with the new ad. The battle between marketers and consumers would become moot. Instead it would be truly innovative and a worthy extension of the social graph.

That leads me to the premise of the viral-loop application I created. You can find it on Facebook, MySpace, and other social networks, and at viralloop.com; it acts as a proof of concept for my book, Viral Loop. The widget takes advantage of the interconnectedness of today’s socially networked society. Think about it: Without the active participation of its hundreds of millions of members, Facebook wouldn’t have achieved a multibillion-dollar valuation. So when the app is installed on Facebook (or any other social network), it assigns a viral quotient to the user, telling him how much he’s worth, in dollars, to that social network. This is based on an algorithm that takes into account such variables as the company’s current valuation and the user’s level of activity, the level of activity of all his “friends,” and his influence, expressed, in large part, by his ability to persuade others to download the widget.

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By placing a dollar value on social-network activity, I am offering incentives to the user to raise his level of participation and spread the widget. A real-time leader board, published on FastCompany.com, will track the viral quotients and dollar values of Web celebrities and other luminaries so users can see how they measure up. We also list the top-20 users who deploy the widget and their corresponding viral-loop quotients and dollar values.

Once you find out what you’re worth, feel free to ask Mark Zuckerberg for your fair share. After all, without you — and all your friends — there wouldn’t be a Facebook. So if he wants to make money off you, maybe it’s time you got in on the action.